ICFAI BUSINESS SCHOOL, HYDERABAD

Financial Crisis of 2007 and its impact

Submitted to Dr. Kalaa Chenji

In partial fulfillment of
Internship project

By
Section - I

Name N Sudha Sri Vastav

Section I
Seat No. 24
Enrollment No. 21BSPHH01C1312
 IBS Hyderabad Academic Year – 2021-23

INDEX

S. No TOPIC Page No.

1. Introduction 4

2. Backdrop of the crisis 4

3. Genesis and development of the crisis 5

4. Varied Dimensions of the Crisis 9

5. Impact of Economic Crisis on Europe 11

6. Responses to the Global Financial Crisis 12

7. Impact of the Economic Crisis on India 13

8. Aspects of Financial Turmoil in India 14

9. India‘s Crisis Responses and Challenges 17

10. Conclusion 19

11. References
20

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ACKNOWLEDGEMENT

The completion of this assignment gives me much Pleasure. I would like to show my gratitude
to Professor Dr.Kalaa Chenji, Assistant Professor, who introduced me to the Methodology of
work. I am grateful to her for giving me a good guideline for project throughout numerous
consultations. My pleasure and gratitude to her for inspiring me with new ideas and giving
motivation to complete the project. I express my deepest gratitude to her for the guidance and
constant support during the period the project.
I am very grateful to her as she has not only guided me in the right direction but also helped in
solving my problems in all possible ways and teaching new and exciting strategies.
I would also like to expand my deepest gratitude to all those who have directly and indirectly
guided me in writing this project.

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“The policy makers left the financial industry free to innovate — and what it did was to innovate
itself, and the rest of us, into a big,nasty mess.”

Introduction
The global economic crisis is often regarded as an egregious example of unbridled greed and excess
at the price of caution, prudence, due diligence, and regulation. It's true that breaking the rules has
repercussions, and the ripples spread outward like a stone tossed in a pond. Wall Street businesses
breached financial laws and regulations, and the world's people, in general, and the people of the
United States, in particular, are being asked to shoulder the brunt of the consequences.

Financial crises of one type or another occur intermittently every decade or so in various parts of the
world. From Sweden to Argentina, from Russia to Korea, from the United Kingdom to Indonesia, and
from Japan to the United States, financial meltdowns have happened. Each financial crisis is distinct,
yet they all have key characteristics. Overheating of markets, excessive debt leveraging, credit booms,
risk miscalculations, fast outflows of capital from a nation, unsustainable macroeconomic policies,
off-balance sheet transactions by banks, inexperience with new financial instruments, and so on have
all contributed to crises.

Financial institutions, despite their inherent fragility, are the bedrock of economic growth. A
country's well-functioning financial system directs cash to the most productive uses and distributes
risks to those who can handle them. This boosts economic growth and creates new opportunities.
As a result, when financial crises occur, they are usually highly costly. In general, nations that
undergo financial crises have significant slowdowns in their growth rates.
Asset bubbles, according to economists, have increasingly provided the fuel for booms in modern
capitalism. They found that the risk of crises increased with the size and duration of economic
booms, and that asset price, production, terms of trade, and interest rate shocks cause financial
crises. The US economy has become increasingly reliant on bubbles to kick-start and maintain
economic expansions. The dot-com bubble burst, causing a crisis, and was followed by the housing
bubble, which sparked a new boom that has now come to an end, precipitating a massive financial
crisis and what appears to be a severe depression akin to the 1930s.

Backdrop of the crisis

1. Boom in World Economy and Thriving Asset Prices
The international economy had been performing remarkably well in the years leading up to the
turmoil, another period of what has come to be known as the "Great Moderation." Following
the worldwide recession of 2001, the global economy recovered quickly, with growth rates
reaching new highs in 2004, 2005, and 2006. Prior to the crisis, there was a global drive for
return and a broad under-pricing of risk by investors due to a lengthy period of plentiful
liquidity and low interest rates. Due to a drop in lending standards and greater leverage, loan
volumes grew significantly in many nations, contributing to asset price and commodity
bubbles.

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2. Growth in US Economy - Interest Rate Cut and Deregulation

There were "global imbalances," according to one important school of thinking represented by
Paul Krugman, the phenomena of big current account surpluses in China and a few other nations
coexisting with unsustainable large deficits in the United States. The tendency of nations with high
savings rates to park their funds in the United States at low returns produced this mismatch. The
influx of funds from these nations kept interest rates low, fueled the credit bubble, and inflated real
estate and other asset prices to unsustainable levels in the United States.
3. Rapid increase in credit
Credit aggregates, like monetary aggregates, had been quickly increasing against the backdrop of
record low interest rates and soaring asset prices. Despite the fast expansion of credit, corporate
balance sheets and repayment capability, as well as those of individuals, did not appear to be
strained. Leverage ratios were kept in control by high asset prices, while debt service ratios were
kept in check by a combination of robust revenue flows and low interest rates.
4. Failure of the US Leadership in Anticipating the Crisis
During the housing boom, the majority of US officials were oblivious to the situation. "I would tell
audiences that we were confronting not a bubble but froth – dozens of tiny local bubbles that never
developed to a size that might jeopardize the health of the general economy," Alan Greenspan, the
then-chairman of the Federal Reserve, wrote in his book "The Age of Turbulence." Even
throughout his term, President George W. Bush never addressed the housing boom in public
statements. The authorities of the United States were reportedly aware of the possibilities of real
estate bubbles, but they did not foresee the disastrous repercussions. As a result, the speculative
housing market received significant investment stimulus, resulting in substantial losses for all
players in the case of a catastrophe.

Genesis and development of the crisis

1) Sub-prime mortgage
The sub-prime mortgage crisis in the United States in 2007 sparked the worldwide economic crisis.
Real estate prices in the United States have been quickly growing since the late 1990s, thanks to
easy access to financing at low interest rates, and home investment has provided a secure financial
return. Between 1997 and 2005, house ownership in the United States increased in all areas, all age
categories, all racial groupings, and all income levels. The housing boom led both banks and house
purchasers to think that real estate prices would continue to rise. Housing financing appeared to be
a fairly safe investment. Banks went out of their way to lend to sub-prime customers with no assets
to back up their loans. However, in 2007, the housing bubble crashed. Home values have dropped
between 20% and 35% since their peak, with some places seeing a 40% drop; mortgage rates have
also risen. A substantial number of sub-prime borrowers began to default. The banks were forced
to declare massive losses

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2) Securitization and Repackaging of Loans

The mortgage market crisis that began in the United States was a complicated problem involving a
wide variety of financial market instruments that went beyond sub-prime mortgages. The fact that
the banks/lenders or mortgage originators who marketed sub-prime home loans did not hang onto
them was an intriguing feature of the crisis. Through a process known as securitization, they sold
them to other banks and investors. Securitization has gained popularity in the United States as a
financial practice. Indeed, just 10% of mortgages in the United States were securitized in 1980,
compared to 56% in 2006.
In the midst of the housing bubble, lenders lured the ignorant, with bad credit histories, to borrow
in the burgeoning sub-prime mortgage industry. They generated and marketed subprime loans
without requiring proper paperwork or doing enough due diligence, and they passed the risks on to
investors and securitizers without assuming responsibility for eventual defaults. These subprime
mortgages were securitized, repackaged, marketed, and resold to investors all over the world as
successful investment products. As investors seeking large profits, they had a strong incentive to
lend to riskier borrowers and were ready to buy securities backed by sub-prime mortgages. At
every level of the financial engineering process, this type of hazardous risk-shifting occurred.
3) Excessive Leverage
The last issue stemmed from the use of too much leverage. Borrowing was used by investors to
purchase mortgage-backed securities. Some Wall Street banks owed 40 times what they were
worth in debt. The Securities Exchange Commission (SEC) adopted a net capital regulation in
1975 that compelled investment banks to restrict their leverage to 12 times while trading securities
for clients and for their own account. The Securities and Exchange Commission (SEC) permitted
the five major investment banks — Merrill Lynch, Bear Stearns, Lehman Brothers, Goldman
Sachs, and Morgan Stanley – to more than quadruple the leverage allowed on their balance sheets
in 2004, thereby lowering their capital adequacy.
The most heavily indebted institutions have suffered significant losses. Leveraged investors have had
to repay money borrowed to buy anything from stocks to complicated derivatives, causing financial
markets to plummet even more. All of this resulted in the US government stepping in to purchase and
lend in the financial sector, resulting in large rescue packages.

4) Misleading judgements of the Credit-Rating Organisations

Credit-Rating Organizations (CROs) played a part in the financial disaster by instilling a false feeling
of security through complicated grading procedures. For a long time, credit rating organisations such
as Standard & Poor's (S&P), Moody's, and Fitch controlled the worldwide ratings industry. They were
the agencies designated as Nationally Recognized Statistical Rating Organizations by the Securities
and Exchange Commission (SEC), the US capital markets regulator (NRSRO). These CROs were
compelled to publish their techniques as NRSROs with a quasi-regulatory function. However, these
credit rating companies employed statistical models that had not been thoroughly validated and
provided favourable judgements on the underlying loans. There were no protections in place for
putting up an effective information system to deal with potential delinquencies and defaults.

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5) Mismatch between Financial Innovation and Regulation

It should come as no surprise that government throughout the world attempt to regulate financial
institutions in order to avert crises and ensure that a country's financial system effectively supports
economic development and opportunity. It's critical to strike a balance between freedom and
constraint. Financial innovation invariably increases risks, but a highly regulated financial system
stifles growth. When regulations are either too strict or too loose, they harm the same institutions
they are supposed to safeguard.
In the context of the crisis, it's important to remember that over the last four decades, financial
firms in the United States have spent a lot of time and effort developing mechanisms and structures
to exploit gaps in the regulation and oversight of financial institutions. Financial globalization
aided this development by allowing businesses and financial institutions to strategically book their
operations overseas to avoid onerous restrictions in their home nations. Large and complicated
financial institutions used securitization to avoid limits on their capacity to grow leveraged risk-
taking, but regulatory agencies were unsuccessful in recognizing this.
Everyone, including regulators, was caught off guard by the catastrophe. Regulators were blind to
the impact of derivatives, which obscured the flaws in the underlying transactions.
6) Fair value accounting rules
Banks and other businesses must value their assets at current market prices under fair value
accounting requirements. Fair value accounting's overall goal is to help investors, financial system
players, and regulators better understand the risk profile of securities so that they may better appraise
their position. To do this, financial statements must be responsive to price signals from markets,
which represent transaction values, in the case of instruments for which it is economically important.
The fair value accounting standard, according to investors and regulators, should not be reduced
since it is a critical component of accurate and completely transparent financial statements, which
are the cornerstone of financial activity. Asset owners, on the other hand, believe that accounting
standards should be updated to better represent the reality of financial transactions. They claim that
valuing assets properly has been difficult or impossible in times of illiquidity and declining
markets. As a result of fair-value accounting, assets are now valued at distressed sale prices rather
than their true value, resulting in a downward spiral. Fair value accounting's criteria insured that
what began as a sub-prime crisis evolved into a broad credit deterioration that affected prime
mortgages, resulting in credit downgrades and system-wide markdowns.
7) Typical characteristics of US financial system
Since the 1930s, the financial system of the United States has evolved considerably. Many of
America's major banks have shifted their focus from "lending" to "moving." They concentrated on
buying assets, repackaging them, and selling them while developing a track record of inept risk
assessment and creditworthiness screening. Hundreds of billions of dollars have been spent to keep
these broken organisations afloat. Nothing has been done to alter their irrational incentive systems,
which foster short-sightedness and excessive risk-taking. With private incentives so dissimilar from
societal returns, it's no wonder that self-interest (greed) has resulted in such socially harmful
outcomes. Even their own stockholders' interests have not been properly represented.
The crisis in the United States was shaped by the typical characteristics of the US financial system,
which included a complex mortgage financing value chain with opaque securitization structures, a
large ‗shadow financial system' involving various poorly regulated intermediaries (investment

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banks, hedge funds, structured investment vehicles – SIVs) and instruments (credit default swaps).
Poor lending standards, the development of non-transparent securitization structures, poor risk
management across the securitization chain, and the accumulation of excessive debt by financial
institutions were all allowed due to a lack of prudential monitoring.
8) Failure of Global Corporate Governance
Failures in corporate governance led to non-transparent incentive systems that fostered poor
accounting methods, which is one of the causes of the present crisis in advanced industrial
countries. Emerging markets and developing nations are underrepresented, and in some cases not
represented at all, in the governance of international economic organisations and standard-setting
bodies such as the Basle Committee on Banking Regulation. The International Monetary Fund, for
example, has been wed to certain economic viewpoints that have given little heed to the inherent
dangers in developed-country policies. According to the IMF, market discipline still works, and
any rules should focus on enhancing market discipline and addressing market participants'
tendency to underestimate the systemic implications of their collective actions rather than
eliminating risk. On the contrary, it has frequently put pressure on developing nations to follow
macroeconomic policies that are not only harmful to them but also contribute to increased global
financial instability. The global economic organization‘s discriminatory practices exposed their
key flaws in establishing trust, legitimacy, and effectiveness.
9) Complex Interplay of multiple factors
It can be argued with some assurance that sub-prime mortgages are not the only cause of the global
economic crisis. There are a number of causes that contributed to such a massive disaster. The G-
20 member states' declaration, issued during a special summit on the global financial crisis on
November 15, 2008 in Washington, D.C., recognised the fundamental causes of the present crisis
and placed them in context. Market players sought greater returns without an appropriate
awareness of the risks and failed to perform basic due diligence during a period of robust global
growth, rising capital flows, and extended stability earlier this decade. At the same time, the
system was vulnerable because to lax underwriting standards, poor risk management procedures,
more complex and opaque financial instruments, and excessive leverage. In several industrialised
nations, policymakers, regulators, and supervisors failed to recognise and manage the growing
dangers in financial markets, keep up with financial innovation, or consider the systemic
implications of local regulatory measures. Inconsistent and poorly coordinated macroeconomic
policies, as well as inadequate structural changes, were major underlying reasons in the current
predicament, leading to unsustainable global macroeconomic results. These events, taken together,
lead to market excesses and, as a result, serious market disruption.

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Varied Dimensions of the Crisis

1) Global spread of the crisis
The structure of the US economy, according to experts, has led to the internationalization of the
crisis. America's financial system failed in two critical areas: risk management and capital
allocation. It is thought that a large number of micro-failures led to a large macro-failure. Not only
had the US financial sector made bad loans, but it had also engaged in multibillion-dollar bets with
one another via derivatives, credit default swaps, and a slew of new instruments, all of which were
opaque and complicated to the point where the banks couldn't even see their own balance sheets,
let alone those of any other bank to which they might lend. The credit markets went into a halt.
Unfortunately, many of the worst aspects of the US banking system have been transferred to other
countries. As a result, the financial upheaval that erupted in the United States enveloped not only
that country, but the whole world. The failure of several of the financial world's heavyweights has
frightened nations far away from the United States. It's hard to imagine that some of the world's
largest investment banks and real estate companies have become relics of the past. It has wreaked
havoc on the global economy, and the waves of credit contraction and distrust in today's financial
institutions have become a sad reality all across the world.
The crisis has had a significant impact on both developed and emerging economies. In current
period of globalization, global financial capital has essentially touched all economies, depending
on the amount to which they have been opened up. National economies throughout the world are
vulnerable to diminishing capital flows, large capital withdrawals resulting in stock market losses,
employment losses, pressure on national currencies, and rising interest rates, among other things.
Between investors and customers, there is a crisis of confidence and trust. Those who believe it is a
disease that only affects affluent countries should reconsider their assumptions. The financial crisis
on the other side of the Atlantic has an impact on every economy on the planet. Its gravity may be
gauged by the fact that then-US President George W. Bush convened a conference of G-20
countries to create a plan to address the economic crisis.
2) Financial globalization
The development of financial globalization has been regarded as undermining demand
management in capitalist nations and removing a slew of regulatory tools proposed by John
Maynard Keynes. It is true that current demand generation comes from the stimulation of private
expenditure, which is typically linked with the formation of asset price bubbles, rather than from
governmental expenditure, which is associated with asset price stability. The state's ability to act
effectively in the national economy has been severely harmed by the unrestricted worldwide
movement of money. This has exposed the economy to the whims and caprices of speculators,
inflicting severe harm to the system's stability and sustainability by influencing productive
investment and raising demand, production, and employment levels. Regulation enforcement has
been the largest victim in this permissive environment. In a market-driven economy, the market's
ability to self-adjust and self-correct was given much too much weight.

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3) Decline in the Credibility of International Financial Organizations

International financial organisations and institutions have been thrown into sharp light as a result
of the financial crisis. The International Monetary Fund, the Financial Stability Board, and the
Bank for International Settlements, as well as the World Bank, the Group of Seven (G-7), the
Group of Twenty (G-20), and other organisations that help countries coordinate policy, provide
early warning of impending crises, or act as lenders of last resort, are among them. Any worldwide
financial framework with monitoring, regulatory, or supervisory power has yet to be established.
The interconnectedness of global financial and economic markets, on the other hand, has
highlighted the need for stronger institutions to coordinate regulatory policy across countries,
provide early warning of dangers posed by systemic, cyclical, or macro prudential risks, and
prompt national governments to take corrective action.
4) Credit Crunch
Economic downturns have historically led in panic as a result of abrupt shifts in financial market
sentiment. When anything went wrong, such as a borrower's failure to satisfy payment
commitments, people worried. As a result, consumers withdrew money from banks, and banks
stopped lending. Maintaining sufficient liquidity in the banking system has remained a serious
challenge in such a circumstance. As a result, capital injections into banks are commonly seen as
an enabling strategy for providing more liquidity and improving solvency. There is a lot of
uncertainty about how long and deep the credit crisis will last. Spreads on asset-backed securities
have widened, and high-yield bonds and inter-bank loan markets have been severely strained.
Major Banks have written off significant losses, further restricting lending.
5) Crisis of Confidence and Credibility in the Financial Market
When a few major financial institutions went bankrupt, the whole financial system was thrown into
chaos. In the financial hubs, banks ceased lending to each other due to widespread anxiety.
Proactive lending was not a priority for banks. The financial markets in the West have become
paralyzed by fear. The entire incident has shown unrestrained greed and widespread corruption,
which have been allowed by governments that have lost sight of their responsibilities to safeguard
their population. The major stakeholders' credibility has been destroyed.
6) Failure in addressing global issues such as Climate Change
The global economic crisis in wealthy nations and abroad has also played a role in the limited
worldwide attempts to establish international agreements on problems such as climate change. The
rate of global economic growth is slowing. National economies' budgets are likewise tightening.
There is a larger likelihood of fewer resources being available to address the global problem of
climate change in this scenario. With the severity of the economic crisis, the agenda for concerted
global action to achieve significant reductions in Green House Gas emissions has been lowered.
However, in order to assure long-term growth, climate change concerns must be given top priority
in the development plan, particularly when it comes to creating employment, securing energy
supplies, and introducing new technology. Clearly, the globe is experiencing two crises at the same
time. The global financial crisis is virtually immediate; climate change is more existential. The
first's urgency is no excuse for ignoring the second. It is, on the contrary, a chance to kill two birds
with one stone.

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Impact of Economic Crisis on Europe

Financial markets in the United States and Europe have become increasingly interconnected as a
result of cross-border investment by banks, securities brokers, and other financial businesses.
Economic and financial changes that affect national economies are difficult to contain as a result of
this interconnectedness, and they are swiftly transferred across national borders. Financial
institutions' actions can spill over into other regions when they remove assets from overseas
markets to shore up their home operations in response to a financial crisis in one area. As US
businesses operating in Europe and European firms working in the United States have changed
their operations in reaction to the crisis, European banks and financial firms have felt the effects of
the US financial crisis. In a nutshell, the crisis has highlighted the increasing interconnectedness of
financial markets and the economies of the United States and Europe. As a result of the present
economic slump's synchronized character, neither the United States nor Europe are likely to
emerge from the financial crisis or the economic downturn alone.
The crisis has had a negative influence on Europe's economic activity, affecting all critical sectors
of national economic growth and people's economic wellbeing. The current economic slowdown
has morphed into a worldwide, coordinated decline. Tighter financial conditions, declining wealth,
and more uncertainty have resulted in a significant drop in demand across the board. This decline
in demand has resulted in a historic drop in trade: euro area exports fell by 26% on an annual basis
in the fourth quarter of 2008
Europe's share of global commerce has plummeted, putting European export prospects in jeopardy.
Furthermore, rising unemployment rates, as well as fears about escalating financial and economic
upheaval, are raising the political stakes for European governments and leaders. The impact has
been so severe that European economic growth is anticipated to decrease by roughly 2% in 2009,
resulting in a 0.2 percent drop in growth. The US economy is predicted to expand at a negative 1.6
percent pace in 2009, while the euro area nations are likely to grow at a combined negative rate of
2.0 percent, down from a projected rate of 1.2 percent in 2008. Furthermore, the global economic
crisis is putting a pressure on the bonds that bind European Union members together in pursuit of
common aims and interests.
Many of the causes that contributed to the financial crisis in the United States caused a comparable
problem in Europe, according to a research by the International Monetary Fund (IMF). Low
interest rates, a complicated mortgage securitization process, bank and financial institution
leveraged debt, the emergence of perverse incentives and complexity for credit rating
organisations, and greater links across national financial centers all contributed to credit expansion
and economic growth. The value of shares, commodities, and physical assets like real estate all
increased as a result of this fast expansion. These variables converged in July 2007 to erode the
perceived value of a variety of financial instruments and other assets, while increasing the
perception of risk associated with financial instruments and the credit worthiness of a wide range
of financial businesses. In July 2007, when credibility issues in the US subprime mortgage market
began to surface, risk perception in European credit markets began to shift. Although European
mortgages were originally untouched by the drop in mortgage values in the United States, the
financial upheaval rapidly extended throughout Europe.

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Responses to the Global Financial Crisis

The first steps taken by the US and other countries in dealing with the global financial crisis were
to contain the spread of the crisis, minimize societal losses, restore confidence in financial
institutions and instruments, and lubricate the system's wheels so that it could return to full
operation. The focus is on reviving the economy and halting the macroeconomic downturn that is
driving rising unemployment and putting many businesses into bankruptcy. Since the crisis began,
it is believed that as much as 40% of the world's wealth has been lost. However, there is still a lot
of uncertainty about whether the worst of the crisis has passed and if the current monetary and
fiscal policies will be enough to deal with the global recession. It's also unclear if the present
problem is a one-off that can be resolved by fine-tuning the system, or if it indicates structural
flaws that would necessitate a comprehensive redesign.
The following are the responses of countries throughout the world to various aspects of the crisis:
1) Containing the Contagion and Strengthening Financial Sectors
Intervention was used in the first phase to control the spread of the disease and improve financial
sectors in countries. On a macroeconomic level, this has included decreasing interest rates,
boosting the money supply, and steps to restart and restore credit markets' trust. On a
microeconomic level, this has involved steps such as financial rescue packages for failing
businesses, bank deposit guarantees, capital infusions, the disposal of toxic assets, and debt
restructuring. The government has taken strong action in this regard. Financial institutions have
been rescued, and certain financial institutions have been taken over, as well as mergers and
acquisitions have been facilitated by the government.
Almost all of the short-term remedies to the problem offered in the United States resemble a
bailout. This is true of the Federal Reserve's interest rate cuts, its lending to troubled institutions,
tax rebate checks mailed to individuals, the Federal Housing Administration's extension of loan
limits, and the Government-sponsored enterprises Fannie Mae and Freddie Mac's extension of
mortgage ceilings. Following the crisis, special emphasis was devoted to ensuring the capital
sufficiency of banks and other lending institutions, which were under growing strain as their assets
continued to plummet. To avert additional system freeze-ups, which might spread quickly during
the crisis, care was taken to recapitalize the banks.
2) Coping with Macro-economic Effects
Countries all around the world are dealing with the crisis's macroeconomic effects on their
economy, businesses, investors, and households. The considerable capital outflow from their
economies, as well as decreasing exports and commodity prices, have dragged down many of these
nations, particularly those with growing and developing markets. To deal with recessionary
economic conditions, decreasing tax collections, and growing unemployment, governments have
resorted to traditional monetary and fiscal measures in these instances. The delay, though, is
widespread. The result of this slowdown is a significant drop in growth rates in the United States
and other countries. All major economies, including the United States, the United Kingdom,
Germany, Brazil, Mexico, Russia, China, Japan, and South Korea, are suffering a growth
slowdown. There is no large economy that can act as an economic engine to lift other countries out
of their recessions.

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3) Regulatory and Financial Market Reform

World leaders launched a series of international summits to discuss changes in policy, rules,
monitoring, and enforcement in order to bring about significant reforms in national regulatory
systems. These gatherings have been dubbed "Bretton Woods II" by some. The G-20 Leaders'
Summit on Financial Markets and the World Economy, which took place in Washington, DC on
November 15, 2008, was the first of a series of summits to address these concerns. The second was
the G-20 Leaders' Summit in London on April 2, 2009, and the third is scheduled for November
2009.
The immediate concerns raised by the United States and other countries concern structural flaws
that might lead to future catastrophes. Regulatory and monitoring of financial markets, derivatives,
and hedging activities, as well as capital adequacy rules, are all part of this. The leaders of the G-
20 summit in November 2008 agreed an Action Plan that lays out a thorough work plan.
The G-20 leaders addressed the issue of international financial system coordination and oversight
at the London Summit by establishing a new Financial Stability Board (FSB) as a successor to the
Financial Stability Forum, with a strengthened mandate to collaborate with the IMF to provide
early warning of macroeconomic and financial risks and the actions required to address them.
Individual nations will be in charge of overseeing internationally active financial firms and
reshaping regulatory structures to identify and mitigate systemic risks, according to the Summit.
Hedge funds should be regulated, tax havens should be targeted, and credit rating agencies should
be regulated and registered, according to the London Summit.

Impact of the Economic Crisis on India

Offshoot of Globalized Economy

With India's economy and financial markets becoming more integrated with the rest of the globe,
it's becoming clear that the country faces significant downside risks as a result of these global
trends. The risks stem primarily from the possibility of a protracted reversal of capital flows, as
well as certain components of possible financial contagion, as a result of the global economy's
expected slowdown, particularly in advanced nations. The negative impacts in India have so far
been mostly in the stock markets as a result of portfolio equity flows reversing, as well as the
accompanying repercussions on the domestic FX market and liquidity circumstances. The macro
impacts have been subdued thus far due to the general strength of domestic demand, the Indian
business sector's solid balance sheets, and the predominance of local investment finance.
‗‗It is a period of unprecedented difficulties for the global economy," India's Prime Minister has
acknowledged. The financial crisis, which appeared to be isolated in one sector of the financial
system in the United States a year ago, has erupted into a systemic catastrophe, affecting the
closely interconnected financial markets of industrialized nations as well as other markets. It has
suffocated traditional lending channels and precipitated a global stock market crash. The actual
economy has been impacted. It has been dubbed the "worst crisis since the Great Depression" by
many.

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Aspects of Financial Turmoil in India

1) Capital Outflow
The most notable consequence of the global financial upheaval on India has been the substantial
shift in the capital account in 2008-09 compared to the previous year. In April-June 2008, total net
capital flows dropped from $17.3 billion in April-June 2007 to $13.2 billion. Nonetheless, capital
inflows are projected to be more than enough to cover the current account deficit again this year.
While FDI inflows have continued to accelerate (US$ 16.7 billion in April-August 2008 versus
US$ 8.5 billion in the same period of 2007), portfolio investments by foreign institutional investors
(FIIs) experienced a net outflow of about US$ 6.4 billion in April-September 2008 versus a net
inflow of US$ 15.5 billion in the same period of 2007.
Similarly, corporate sector external commercial borrowings fell from US$ 7.0 billion in April-June
2007 to US$ 1.6 billion in April-June 2008, partly as a result of governmental responses to excess
flows in 2007-08, but also as a result of the present turbulence in advanced countries.
2) Impact on Stock and Forex Market
The impact of global financial upheaval was felt most acutely in the equities market during 2007
and 2008, when portfolio movements were very volatile. Withdrawals by foreign institutional
investors (FIIs) have had a significant impact on Indian stock prices. Between January 2006 and
January 2008, FIIs invested about Rs 10,00,000 crore, propelling the Sensex to a high of 20,000.
FIIs, on the other hand, dropped out of the stock market from January 2008 to January 2009, partly
as a flight to safety and partially to satisfy their redemption commitments at home. The Sensex fell
from over 20,000 to less than 9,000 in a year as a result of these withdrawals. The stock market's
liquidity has been severely harmed. Stock values have plummeted by more than 70% from their
high in January 2008, with some losing as much as 90% of their value. This has left investors, both
retail and institutional, with no safe haven. The main market has come to a halt, and the secondary
market has plunged into the abyss.
3) Impact on the Indian Banking System
The absence of apparent contagion seen by banking systems in developing economies, notably in
Asia, has been one of the main aspects of the present financial upheaval. Similar to its Asian
counterparts, the Indian financial sector has not been affected by the virus.
Subprime mortgage assets are not directly exposed to the Indian banking system. It has just a small
amount of indirect exposure to the US mortgage market, failing banks, and stressed assets. Indian
banks are financially healthy, properly funded, and tightly regulated, both in the public and private
sectors. As of end-March 2008, the average capital to risk-weighted assets ratio (CRAR) for the
Indian banking sector was 12.6%, compared to the regulatory minimum of 9% and the Basel norm
of 8%.
Following Lehman Brothers' filing for bankruptcy, all banks in India and overseas were urged to
submit the specifics of their exposures to Lehman Brothers and affiliated businesses. 14 of the 77
reporting banks said they have exposure to Lehman Brothers and its affiliates in India or abroad.
The majority of the exposures disclosed by these institutions belonged to subsidiaries of Lehman
Brothers Holdings Inc., which are not covered by the bankruptcy proceedings, according to an

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examination of the information submitted by these banks. Overall, these institutions exposure,
particularly to the insolvent Lehman Brothers Holdings Inc., is not large, and banks are said to
have taken appropriate preparations. Following the upheaval created by bankruptcy, the Reserve
Bank has announced a number of steps aimed at facilitating orderly financial market operation and
ensuring financial stability, the most prominent of which is the offer of extra liquidity support to
banks.
4) Impact on Industrial Sector and Export Prospect
The financial crisis has manifested itself in real life. It has reduced the industrial sector's growth,
which is expected to fall from 8.1 percent last year to 4.82 percent this year. Aside from the
transportation, communication, commerce, and hotels & restaurants sub-sectors, the service sector,
which accounts for more than half of GDP and is the primary growth engine, is slowing. In the
manufacturing sector, growth slowed to 4.0 percent in April-November 2008, compared to 9.8
percent in the same period the previous year. Export-driven industries such as gems and jewelers,
textiles and leather, to mention a few, have been severely harmed by sluggish export markets.
During October 2008-February 2009, exports fell in absolute terms for the first time in seven years
for five months in a row.
In a globalized economy, recession in wealthy nations will always have an influence on emerging
economies' export sectors. The expansion of India's economy depends on export growth. Export
growth has been negative, prompting the government to reduce the current year's export objective
from $200 billion to $175 billion.
5) Impact on Employment
Industry employs a huge number of people. When the industrial sector suffers a setback, it has a
cascade effect on the job situation. The services sector has been impacted since the hotel and
tourism industries rely heavily on high-value international visitors. Real estate, construction, and
transportation are all harmed. Aside from GDP, the consequences for employment are of greater
importance. According to a study done by the Ministry of Labour and Employment, five lakh
people lost their employment in the fourth quarter of 2008. Textiles, Automobiles, Gems &
Jewellery, Metals, Mining, Construction, Transportation, and BPO/IT industries were all included
in the study, which had a very high sample size. These industries' employment fell from 16.2
million in September 2008 to 15.7 million in December 2008. Furthermore, employment in the
manual contract category of employees has decreased in all of the sectors/industries studied.
6) Impact on poverty
The country's poverty situation is heavily influenced by the economic crisis. Increased job losses in
the manufacturing industry's manual contract category, as well as ongoing layoffs in the export
sector, have pushed many people to live in poverty. The World Bank's study, "The Global
Economic Crisis: Assessing Vulnerability with a Poverty Lens," includes India among the nations
having a "high vulnerability" to increasing poverty risk as a result of the global economic crisis. A
humanitarian catastrophe of hunger is also present. According to the Food and Agriculture
Organization, the global financial crisis has led to the rise of hunger. Currently, 17% of the world's
population is undernourished. India would be badly impacted since, even before the financial
crisis, the country had 230 million undernourished people, the greatest number of any country on
the planet.

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7) Indian Economic Outlook

The global crisis has knock-on consequences in India through the monetary, financial, and real
channels, all of which are on top of the previously projected cyclical economic slowdown. Financial
markets, including the stock market, money market, currency market, and credit market, have all
been impacted by what has been dubbed "the replacement effect" of:
i) A lack of offshore funding for Indian banks and corporates
ii) Difficulties obtaining money in a pessimistic local capital market
iii) A drop in corporate internal accruals. All of these issues added to the domestic credit
market's stress. Simultaneously, the global de-leveraging process has created a reversal of capital
flows, putting pressure on our currency market. In October 2008, the significant fluctuations in
overnight money market rates, as well as the rupee's devaluation, showed the combined impact
of the global credit crunch and the ongoing deleveraging process.

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India’s Crisis Responses and Challenges

1) State of Economy in Crisis Time
There were numerous reassuring aspects leading up to the slowdown. To begin with, our financial
markets, especially our banks, have continued to operate regularly. Second, despite weaker export
demand and slowed capital flows, India's healthy foreign exchange reserves provide us confidence
in our capacity to manage our balance of payments. Third, the wholesale pricing index (WPI) has
shown a significant decrease in headline inflation. Inflationary pressures on consumers have also
begun to ease. Fourth, rural demand is strong due to mandatory agricultural financing and social
safety-net programmes. India's economy has stagnated since the last quarter of 2008, after
averaging 9% growth over the previous four years. Furthermore, the slowdown resulting from the
difficult adjustment to rapid changes in the world economy has led in revisions to growth
expectations. In its evaluation of the economy for the year 2008-09, the Prime Minister's Economic
Advisory Council reduced the GDP growth to 7.1 percent. The RBI's Annual Policy Statement, on
the other hand, forecasts real GDP growth of 6.0 percent in 2009/10. Domestic demand has
slowed, both in terms of private consumption and investment spending, notwithstanding an
increase in government final consumption due to discretionary fiscal stimulus measures. The
global financial crisis highlighted the complex interplay between financing availability and market
circumstances. Both the government and the Reserve Bank of India responded to the issue of
reducing the crisis' impact on India by working together and consulting.
2) RBI’s Crisis Response
On the financial front, the Reserve Bank of India has taken a number of steps to align risk
management with fiduciary and regulatory obligations. The Reserve Bank's policy reaction was
targeted at limiting the global financial crisis's contagion while preserving enough domestic and
foreign currency liquidity. The Reserve Bank's policy stance moved from monetary tightening in
reaction to rising inflationary pressures in the first half of 2008-09 to monetary easing in response to
lowering inflationary pressures and the crisis-induced slowing of GDP. The Reserve Bank's efforts
have made a total of roughly 7% of GDP in primary liquidity potentially accessible to the banking
sector. Most banks have lowered their deposit and lending rates in response to the Reserve Bank's
monetary easing. In addition, the RBI established a calibrated regulatory framework to address the
issue of systemic risk, which included prudential capital requirements, exposure norms, liquidity
management, asset liability management, entity profiling and reporting requirements, corporate
governance, and disclosure norms for non-banking finance companies classified as systemically
important.
3) Government’s Crisis Response
Between December 2008 and February 2009, the government introduced three fiscal stimulus
measures. These stimulus packages were added to a previously announced enhanced safety-net
programme for the rural poor, as well as farm debt waivers and payouts in response to the Sixth
Pay Commission Report, all of which helped to boost demand. These fiscal policies have a
cumulative impact of roughly 3% of GDP.
There are several obstacles to implementing the fiscal stimulus packages, including increasing
public investment, reviving private investment demand; unwinding fiscal stimulus in a timely
manner, maintaining credit flow while ensuring credit quality, maintaining financial stability while
providing adequate liquidity, and ensuring an interest rate that is competitive.

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Fiscal and monetary stimulus measures implemented in 2008-09, along with reduced commodity
prices, are expected to soften the slump by stabilizing domestic economic activity. Overall, real
GDP growth for 2009-10 is expected to be approximately 6%. By the end of March 2010,
inflation, as measured by changes in the WPI, is expected to be about 4.0. Consumer price
inflation is also falling, but more slowly. Despite a number of problems, India's economy is robust,
thanks to well-functioning markets and solid financial institutions In comparison to numerous
other advanced and developing market economies, India‘s macroeconomic management has
managed to maintain reduced volatility in both the financial and real sectors. The government
pushed economic openness and globalization in a way that more judiciously mixes the market and
the state than some other economies.

4) The Risks and Challenges

While the dangers associated with global financial market uncertainty continue to exist, there are
also concerns on the local front. The problem is figuring out how to handle the recuperation. The
current fiscal and monetary measures will have to weigh in on the economy's health in the next
months. If the global economy takes hold and private investment demand picks up more quickly,
there may be less need for more assistance. Risk management in the macro economy is a daunting
task. Clearly, there are no simple solutions; nonetheless, three aspects: monetary policy, fiscal
policy, and financial stability deserve specific attention in order to comprehend the contours of
uncertainty.
5) Monetary policy
On the monetary policy front, risk management necessitates adequate liquidity in the system. Over
the last six months, the RBI has done so using a range of instruments and facilities. It also
extended the term of many of these facilities in the April 2009 policy review. Some would argue,
and correctly so, that this might be the beginning of the next inflationary cycle. And this is the type
of danger with which one must contend. While the Reserve Bank will continue to support the
economy's liquidity, it must guarantee that excess liquidity is pulled back in a timely way when
economic development gains traction.
6) Fiscal policy
The issue for fiscal policy is to strike a balance between immediate economic stimulus and the
need to get back on track with medium-term budget reduction. The fiscal stimulus packages and
other measures have resulted in a dramatic increase in revenue and fiscal deficits, which have
cushioned the pace of economic activity in the face of decreasing private investment.
7) Financial stability
Financial stability, in addition to monetary and fiscal policy, is critical for navigating these
difficult times. Financial stability requires a strong and resilient banking sector, well-functioning
financial markets, solid liquidity management, and a well-functioning payment and settlement
system. India's banking system is strong, well-capitalized, and well-regulated. By all accounts, the
Indian financial markets would be able to weather the global shock, perhaps wounded but not
beaten.

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Conclusion
For a number of factors, India has largely avoided global financial contagion as a result of the
subprime mortgage crisis. India's growth has been primarily fueled by local demand. The credit
derivatives market is still in its early stages; financial sector developments in India are not
comparable to those in mature countries; citizens cannot participate in such products produced
outside of India; and regulatory limitations on securitization do not allow for aggressive profit
making. Financial stability has been established in India thanks to the persistence of prudential
rules that have kept institutions from taking excessive risks and financial markets from becoming
very unpredictable and chaotic.
Despite this, the global economic recession has impacted our economy's most critical sectors,
posing severe challenges to economic development and livelihood security. The crisis is pushing
nations all around the world to put their fiscal and monetary powers to the test. India is no
different. The government and the RBI have adopted a number of fiscal and monetary measures to
mitigate the effects of the slowdown while also restoring economic buoyancy.
In order to fulfill the main objectives of rural regeneration, poverty reduction, inclusivity, and
sustainable development, India has intentionally pursued a high growth path. Growth without
inclusion, or growth without jobs, will not assure the balanced and all-round development of all
segments of society. As a result, the question of how long it would persist and how much it would
affect growth rates has taken on crucial importance. The impact of the current slowdown on India's
growth rate is not worrisome. India continues to be one of the world's fastest growing economies.
The World Bank's report "Global Development Finance 2009" makes an accurate prediction that
India would have the highest GDP growth rate of 8% in 2010. The sheer scale of the Indian
economy would aid in its recovery. With the appropriate balance of monetary and fiscal policies,
as well as internal changes in the productive sectors, India's economy has the potential to emerge
stronger than before from the global crisis.

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References
1. Arjun K. Sengupta, ―The financial crisis and the Indian response‖, The Hindu, October 24, 2008
2. Camilla Anderson, IMF Spells Out Need for Global Fiscal Stimulus, International Monetary Fund,
IMF Survey Magazine: Interview, Washington, DC, December 29, 2008
3. Declaration of the G-20 Summit on Financial Markets and the World Economy November 15,
2008, Washington DC,
4. ―Fair-value accounting rules not fair‖, The Banker, November 3, 2008
5. Global Economic Outlook 2008
6. ―Global Financial Crisis: Analysis and Policy Implications‖, Congressional Research Service,
Report for Congress, April 3, 2009
7. International Monetary Fund. ―The Recent Financial Turmoil – Initial Assessment, Policy Lessons,
and Implications for Fund Surveillance,‖ April 9, 2008
8. N.K. Singh, ―Think beyond stimulus plans‖, Mail Today, March 16, 2009
9. ―Origins of the Crisis‖, The Hindu (Editorial), March 11, 2009
10. Prime Minister of India‘s statement at the Summit of Heads of State or Governments of the G-20
countries on ―Financial Markets and the World Economy‖ held at Washington on November
11. Speech of the President of the 63rd Session of the UN General Assembly at the meeting of the
Interactive Panel on the Global Financial Crisis, New York, October 30, 2008
12. Statement by Dr. D. Subbarao, at the International Monetary and Financial Committee,
Washington D.C, April 25, 2009
13. C. Rangarajan, ―The financial crisis and its ramifications‖, The Hindu, November 8, 2008
14. The Statement from G-20 Summit on ―Financial Markets and the World Economy‖ held in
Washington on November 15, 2008

Internet sites visited

1. www.economist.com
3. www.rbi.org.in
4. www.telegraph.co.uk
5. www.usa.gov
6. www.whitehouse.gov
7. www.worldbank.org.in
8. www.imf.org

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